Positive growth surprise for IT firms possible

The July-September 2012 results for the IT/ITeS industry and the stock market response may give us some clues about the future price trends in this space. Infosys disappointed. HCL Tech beat expectations by a handsome margin. TCS beat consensus as well due to volume growth but margins dropped. Infosys' share price dropped, and then made a partial recovery. HCL Tech hit new 52-week high. TCS saw a sell off.

There are obvious differences in business models for specific businesses. But there are strong correlations in terms of prices across the IT space. There is a strong historical link to the dollar-rupee rates but that has become a little shaky in the past year or so.

The CNXIT index lists 20 IT businesses. The big four - TCS, Infy, Wipro and HCL Tech - hold 88 per cent weightage. The index futures are illiquid. But as an indicator, the index offers clues about industry price direction.

In the past 12 months, the CNXIT has returned only about two per cent, where the Nifty and Nifty Junior have returned 10.5 per cent and 12.5 per cent, respectively. This gels with an earlier history of counter-cyclical behaviour. The CNXIT outperformed in the last bear market and it can provide a useful hedge. Drilling down, the performance has been pulled down by Infy and Wipro.

What's unusual is the changing correlation with dollar-rupee in the past four-six quarters. A falling rupee has usually meant rising profitability, and vice versa for a rising rupee. Hence, the industry tends to be inversely correlated to the exchange rate.

However, in the past 12 months, this hasn't been true. The USD has risen by about 10 per cent against the rupee since October 2011 but the CNXIT index has not seen a similar performance. The difference may be that the US and global economy has been weak and so, a weak rupee hasn't boosted overseas demand as much as in the past. In the last month though, the rupee recovery of around one per cent has been mirrored by a commensurate fall in the index of about five per cent.

The big gainers in the past 12 months include Vakrangee (bonus + split adjusted basis) MindTree, TechM, HCL Tech, Financial Technologies, NIIT Tech, TCS, Hexaware, and Mphasis. All these stocks have registered returns of over 20 per cent. Big losers include Naukri, Educomp, Polaris and Infy, which have all lost 10 per cent. Wipro has been a small loser.

Traders need to note the following variables. Financial Tech, Educomp, Naukri are not typical IT/ITeS outsourcing models and all have large exposures to the domestic economy. MindTree (up 65 per cent in the past 12 months) has significant rupee exposure due to the UID project. Vakrangee also has high rupee exposure. TechM's share price could fluctuate depending on the specifics of the Mahindra Satyam merger situation. Wipro may see an impact if there is an enforced dilution of promoter stake by 2013.

Vakrangee, Educomp and Polaris have all undergone Sebi investigations. Vakgrangee was cleared of insider trading charges, while Polaris saw its CEO indicted for insider trading, and Educomp paid up under a consent order.

The US economy is consolidating and, perhaps, turning around. Europe is still touch-and-go and India is bottoming out. This could mean a positive growth surprise one or two quarters down the line. I don't think the CNXIT will produce an outperformance by December, but Jan-March may seen it outperforming the broader market. Hexaware, Vakrangee and MindTree look likely outperformers within the IT space. We may have to wait a while for a turnbaround on Wipro and Infy.